(Ab)Use of Complex Financial Instruments by Mutual Funds
44 Pages Posted: 22 Mar 2017 Last revised: 24 Feb 2019
Date Written: February 20, 2019
We study the loosening of restrictions on leverage, short sales, options, and futures use at actively managed U.S. equity funds. We find that the allowance and use of these complex instruments are associated with poor fund performance. The underperformance is most acute when the fund is poorly monitored and when market returns are negative. We also show that these instruments impact fund risk in ways consistent with moral hazard and tournament behavior. Overall, our results suggest that mutual fund investors will benefit from choosing simplicity over complexity.
Keywords: mutual funds, leverage, short sales, options, futures, complex instruments, performance, risk, agency costs, moral hazard
JEL Classification: G11, G23
Suggested Citation: Suggested Citation